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Federal Reserve suddenly loses control of it's own market

“This just doesn’t look good. You set your target. You’re the all-powerful Fed. You’re supposed to control it and you can’t on Fed day. It looks bad.”
- Michael Schumacher, director rates at Wells Fargo.

If the Fed ever lost control of the repo market, doing so on the very day of the Fed meeting is not the day to do it.

As the Fed was meeting to consider cutting interest rates, it lost control of the very benchmark rate that it manages.

It’s a rule of thumb that if you’re even talking about such geeky fare as long-short market-neutral strategies or overnight repurchase agreements, then something has already gone wrong.

You should not even have to be aware of this stuff, and I wouldn't even mention it except that the market essentially broke yesterday, and that might be important. Especially when the Fed basically sets this market.

SOFR is a repo rate: It’s a daily index of the interest rate that banks and hedge funds pay to borrow money overnight, secured by Treasury securities. Repo markets have fallen apart a bit this week, as you might have heard. The Fed’s SOFR data shows some repo trades with interest rates as high as 9% yesterday, and SOFR itself—a volume-weighted index of a broad group of trades—settled at 5.25% yesterday. It was 2.43% on Monday, and had spent the previous month in a range of 2.09% to 2.21%. That’s a normal range, consistent with other short-term interest rates. (The Fed Funds rate is 2.25%, one-month Libor is about 2.04%, one-month Treasury bill rates are about 1.96%, etc.) In the entire (brief) history of SOFR, it had gotten above 3% once, clearing at 3.15% on Jan. 2, 2019. A rate of 5.25% is, in some real but hard-to-define sense, definitely the “wrong” interest rate. It was, however, the SOFR rate yesterday.

So what happened? Yesterday there happened to be less supply and more demand for money, so the rate was high.
That's really what it came down to.

"some weird repo bollocks" happens once every now and then, and the correct response is always¹ to just point and go "hahaha nerrrrd" then go back to some proper work while the roughnecks in the repo mines sort it out.

Most times this is not a big thing. The Fed had been slowly shrinking it's portfolio for some time. This helped cause a liquidity shortage.
The Fed responded by doing an emergency repo (which was oversubscribed).
The long-term effect is that the Fed might be restarting it's QE program (i.e. buying bonds), which isn't good because the Fed was never able to 'normalize' it's portfolio, but it isn't a reason to panic.
OTOH, this should never have happened.

The macro explanations might worry you a bit, if you are inclined to worry; they seem to point to an inability of the financial system to smoothly move money from those who have it to those who need it—that is, an inability of the financial system to do its basic job. Weird big spikes in fundamental financial numbers can indicate deep trouble; they can also cause deep trouble, as risky levered borrowers lose access to funding.

So just as I was about to post this I took a quick look at Zerohedge and there's an update.

20 minutes after today's repo operation began, it concluded and there was some bad news in it: as we feared, yesterday's take up of the Fed's repo operation which peaked at $53.2 billion has expanded substantially, and according to the Fed, today there was a whopping $80.05BN in bids submitted, an increase of $27 billion, or 50% more than yesterday.

It also meant that since the operation - which is capped at $75BN - was oversubscribed by over $5BN, that there was one or more participants who did not get up to €5 billion in the critical liquidity they needed

It's unclear exactly where all this credit demand is coming from, but from what I've read the source is probably from overseas. That's what happens sometimes when you have the world's reserve currency, and everyone borrows in dollars.

would have easily unwound. The rising rates would have dampened P/E and increased demand for bonds.

Throwing the Trump tax cut gasoline on the fire caused the P/E's to shoot higher into the stratosphere than ever before. 40:1 P/E's? Stocks earning 2.5% That's a topsy-turvy world.

We are hitting the limits. ZIRP or negative rates can't drive the S&P to infinity. Especially since consumers are driven to the wall, borrowing just to survive as the vampire 1% suck the blood out of the 99%

This "Trade War" being waged by Washington is a failing effort to force China to "reup" on all those 10 Year Treasuries that China bought to refloat the Fed in 2009. They aren't willing to roll over the bonds at a lower rate, so the Treasury has to pay out.
The word's gone out on The Street that the Fed's accounts are about to go into the red. The result is that the Repo Market is locking up again. I wrote here a couple of months ago that this was about to happen. You heard it first, here, at humble little C99.

China has started to dump $1.2 trillion in U.S. Treasuries it purchased in 2009-2013 that refloated the Federal Reserve emergency fund following the Wall Street meltdown. It is unlikely that China will be buying new U.S. debt securities to replace the hundreds of billions in 10-year Treasury Bills it owns that are now maturing and coming due.

What's next?

The Fed now says that it will resume buying back Treasuries again, and will dump its portfolio of mortgage-backed securities to pay for it - but, where's the real money to reinflate a bankrupted U.S. banking system coming from this time?

During the third quarter of 2008, the American banking system and its credit markets had a near-death experience. While most of us remember the yellow mortgage foreclosure signs that followed, few Americans know that the crisis was set off by a run on U.S. Treasuries by panicked investment bankers.

In October, 2008, trading volume in the then four trillion dollar a day U.S. Treasuries Repo Market -- the primary short-term lending source for big New York investment banks -- dropped 60 percent from levels a month earlier. One academic journal later described the fear and pandamonium by bonds traders this way(1):

[The] Financial Crisis of 2007-2008 was a repo run in two directions. Lenders holding privately-produced collateral in the repo market, e.g., mortgage-backed securities, ran to get their money back while borrowers who had supplied Treasuries as collateral wanted their Treasury collateral back.

After several large investment banks went belly-up during the waning days of the Bush Administration, tens of billions of dollars in Repo trades failed, as other banks were either unwilling or unable to produce "zero risk" U.S. Treasury Bills promised as collateral. The NYT tells the story a few years ago this way:(3)

"Let’s recall. The collapse of investment banks Bear Stearns and Lehman Brothers in 2008 Before it failed, Bear Stearns depended on $50 billion in overnight repo loans that it used to finance the majority of its mortgage-linked securities. A week before it collapsed, Lehman had $200 billion in overnight repo loans. Rescuing Bear through the JPMorgan purchase involved an unprecedented Fed commitment to absorb up to $29 billion in losses. And the Lehman bankruptcy kicked off a $300 billion-single-week run on money market funds and widespread panic."

According to a report yesterday in Bloomberg: (2)

As soon as next year, analysts say the Fed will resume large-scale buying of debt securities -- this time just U.S. Treasuries -- in amounts that may ultimately exceed its crisis-era purchases. According to an estimate by Wells Fargo & Co., the central bank’s balance sheet will rise past its historic peak as it adds over $2 trillion to its Treasury debt holdings in the next decade.

What this Bloomberg article doesn't mention is that since January 2017, the Fed has already gone through half its reserve fund, which it politely refers to as "unwinding" its position in mortgage-backed securities. While the Repo Market was quiet and orderly for years, the bonds traders are going nuts again swapping assets, seeking "haircuts" (the margin between market value and the rate of return available in repo deals) while banks are again hunting the relative safety of Treasuries in the Repo market. It's happening again, only this time, China seems unlikely to bail out the Federal Reserve.

Few Americans seem to be aware that when the U.S. banking system flat-lined during the Third Quarter of 2009, the primary reason it recovered was an infusion of more than a trillion dollars into the Federal Reserve's rainy day fund. During the years of "recovery" that followed money was lent out at negative real interest rates to major American banks. The program was called Quantitative Easing, or "Q.E.", on the street. The source of that injection that literally saved the U.S. economy from collapse a decade ago was a $1.2 trillion purchase of U.S. debt by the Chinese central bank and large state-owned enterprises.

Now, much of that debt to China is coming due, much of it in the form of a colossal stack of 10-year denomination Treasury Bills that are presently coming to maturity.

The renewed roiling of the Repo Markets and the distress of the Federal Reserve and the banking system was inevitable, under the circumstances of conflict with China.

Just a P.S. - after I posted that article in May, someone from the Chicago Federal Reserve accessed my Linked-In page. Linked-In tells you things like that, in case you want to follow-up on a job prospect. Only, I wasn't looking for a job with the Fed, or anything like that. Looks like someone reads C99.

This "Trade War" being waged by Washington is a failing effort to force China to "reup" on all those 10 Year Treasuries that China bought to refloat the Fed in 2009. They aren't willing to roll over the bonds at a lower rate, so the Treasury has to pay out.
The word's gone out on The Street that the Fed's accounts are about to go into the red. The result is that the Repo Market is locking up again. I wrote here a couple of months ago that this was about to happen. You heard it first, here, at humble little C99.

China has started to dump $1.2 trillion in U.S. Treasuries it purchased in 2009-2013 that refloated the Federal Reserve emergency fund following the Wall Street meltdown. It is unlikely that China will be buying new U.S. debt securities to replace the hundreds of billions in 10-year Treasury Bills it owns that are now maturing and coming due.

What's next?

The Fed now says that it will resume buying back Treasuries again, and will dump its portfolio of mortgage-backed securities to pay for it - but, where's the real money to reinflate a bankrupted U.S. banking system coming from this time?

During the third quarter of 2008, the American banking system and its credit markets had a near-death experience. While most of us remember the yellow mortgage foreclosure signs that followed, few Americans know that the crisis was set off by a run on U.S. Treasuries by panicked investment bankers.

In October, 2008, trading volume in the then four trillion dollar a day U.S. Treasuries Repo Market -- the primary short-term lending source for big New York investment banks -- dropped 60 percent from levels a month earlier. One academic journal later described the fear and pandamonium by bonds traders this way(1):

[The] Financial Crisis of 2007-2008 was a repo run in two directions. Lenders holding privately-produced collateral in the repo market, e.g., mortgage-backed securities, ran to get their money back while borrowers who had supplied Treasuries as collateral wanted their Treasury collateral back.

After several large investment banks went belly-up during the waning days of the Bush Administration, tens of billions of dollars in Repo trades failed, as other banks were either unwilling or unable to produce "zero risk" U.S. Treasury Bills promised as collateral. The NYT tells the story a few years ago this way:(3)

"Let’s recall. The collapse of investment banks Bear Stearns and Lehman Brothers in 2008 Before it failed, Bear Stearns depended on $50 billion in overnight repo loans that it used to finance the majority of its mortgage-linked securities. A week before it collapsed, Lehman had $200 billion in overnight repo loans. Rescuing Bear through the JPMorgan purchase involved an unprecedented Fed commitment to absorb up to $29 billion in losses. And the Lehman bankruptcy kicked off a $300 billion-single-week run on money market funds and widespread panic."

According to a report yesterday in Bloomberg: (2)

As soon as next year, analysts say the Fed will resume large-scale buying of debt securities -- this time just U.S. Treasuries -- in amounts that may ultimately exceed its crisis-era purchases. According to an estimate by Wells Fargo & Co., the central bank’s balance sheet will rise past its historic peak as it adds over $2 trillion to its Treasury debt holdings in the next decade.

What this Bloomberg article doesn't mention is that since January 2017, the Fed has already gone through half its reserve fund, which it politely refers to as "unwinding" its position in mortgage-backed securities. While the Repo Market was quiet and orderly for years, the bonds traders are going nuts again swapping assets, seeking "haircuts" (the margin between market value and the rate of return available in repo deals) while banks are again hunting the relative safety of Treasuries in the Repo market. It's happening again, only this time, China seems unlikely to bail out the Federal Reserve.

Few Americans seem to be aware that when the U.S. banking system flat-lined during the Third Quarter of 2009, the primary reason it recovered was an infusion of more than a trillion dollars into the Federal Reserve's rainy day fund. During the years of "recovery" that followed money was lent out at negative real interest rates to major American banks. The program was called Quantitative Easing, or "Q.E.", on the street. The source of that injection that literally saved the U.S. economy from collapse a decade ago was a $1.2 trillion purchase of U.S. debt by the Chinese central bank and large state-owned enterprises.

Now, much of that debt to China is coming due, much of it in the form of a colossal stack of 10-year denomination Treasury Bills that are presently coming to maturity.

The renewed roiling of the Repo Markets and the distress of the Federal Reserve and the banking system was inevitable, under the circumstances of conflict with China.

Just a P.S. - after I posted that article in May, someone from the Chicago Federal Reserve accessed my Linked-In page. Linked-In tells you things like that, in case you want to follow-up on a job prospect. Only, I wasn't looking for a job with the Fed, or anything like that. Looks like someone reads C99.

@leveymg
Bonds are not needed. The bonds are never redeemed. The redemptions are paid for with new issue bonds, so we have printing press money which pays interest.
Better we should just print it directly without the intermediary bonds. But then Wall street would not get their cut.

...I'd been browsing stuff about Gnostic theology, including cosmology charts and a spiel on some kinda spiritual website about how one of the characters on the new Westworld TV series (I've never seen it, though I have seen the original Yul Brynner movie) was a rather overt analogy for the Demiurge.

That all made more sense to me than any of this does.

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In the Land of the Blind, the one-eyed man is declared insane when he speaks of colors.

The FED tinkers with the value of currencies, which should, and used to be tied to the value of actual assets and commodities, not a manipulated money supply. The ecological corollary is the growing natural imbalance caused by the rapacious over consumption of the age of industry and the unchecked growth in the human population. In both economics and life on this planet the larger forces of actual value (reality based supply and demand) and the natural balance (diversity and reciprocity) will win in the end, and in both cases the reckoning ain’t going to be pretty.

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“Unthinking respect for authority is the greatest enemy of truth.”
Albert Einstein

@ovals49
It's like, "Do you want a FREE-MARKET ECONOMY, or don't you, people???" If the government doesn't control the economy, it can't bloody well be held responsible for what happens to it, now can it?

The FED tinkers with the value of currencies, which should, and used to be tied to the value of actual assets and commodities, not a manipulated money supply. The ecological corollary is the growing natural imbalance caused by the rapacious over consumption of the age of industry and the unchecked growth in the human population. In both economics and life on this planet the larger forces of actual value (reality based supply and demand) and the natural balance (diversity and reciprocity) will win in the end, and in both cases the reckoning ain’t going to be pretty.

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In the Land of the Blind, the one-eyed man is declared insane when he speaks of colors.

Building two days ago on my way to Zuccotti Pk to celebrate the 8th anniversary of Occupy. I was completely unaware of the situation explained in the essay.

Pushing two kids uphill on the other side of the block I watched a well groomed man in an expensive suit going in. Just being in those narrows, darkened cavernous streets in which Manhattan Island was first settled by conquering Europeans always gives me a mixture of awe about its history and rage at the vile criminality at the center of world’s financial markets.

It’s now forever etched in me that it is the place of the glorious citizens uprising against Wall St.

So ever single time I’m down there I will just start speaking aloud in the presence of anyone wearing a suit. Things like, “credit default swaps? jail time!”

I looked over at that indescribably humongous and gloomy imposing door of doom in front of the Fed and yelled out to that guy, “prosecute the 1%.”

Fuck these people. They don’t fear us at all. We need to start making them.

I frankly don't understand why, at the heart of a vast metropolis dominated by famously belligerent, supposedly Deep-Blue people, it was merely "Occupy Wall Street"...

...and not something more like "Columbine Wall Street".

Building two days ago on my way to Zuccotti Pk to celebrate the 8th anniversary of Occupy. I was completely unaware of the situation explained in the essay.

Pushing two kids uphill on the other side of the block I watched a well groomed man in an expensive suit going in. Just being in those narrows, darkened cavernous streets in which Manhattan Island was first settled by conquering Europeans always gives me a mixture of awe about its history and rage at the vile criminality at the center of world’s financial markets.

It’s now forever etched in me that it is the place of the glorious citizens uprising against Wall St.

So ever single time I’m down there I will just start speaking aloud in the presence of anyone wearing a suit. Things like, “credit default swaps? jail time!”

I looked over at that indescribably humongous and gloomy imposing door of doom in front of the Fed and yelled out to that guy, “prosecute the 1%.”

Fuck these people. They don’t fear us at all. We need to start making them.

up

0 users have voted.

—

In the Land of the Blind, the one-eyed man is declared insane when he speaks of colors.